Time to end use of commodities for credit in China
Concern over possible abuses in the shadow banking system may prompt crackdown
The mad dash by banks and traders to see who owns what metal inventories at Qingdao port should help bring a swift, and much-needed, end to the practice of using commodities for credit.
For the past few years, one of the known unknowns in the mainland's metal markets has been the use of imports as collateral to secure financing for investments in higher-yielding assets, such as construction.
This has been most apparent in copper, with iron ore, gold, soya beans and other commodities also affected, with the consequent build-up of so-called dark inventories, which are stocks being held for purposes unrelated to supply and demand fundamentals.
The possible unwinding of financing deals may limit any rebound in iron ore prices
It was revealed last week that banks and trading houses were checking their exposure to metal financing at Qingdao, the world's seventh-largest port, amid concern that single cargoes of metal have been used several times to obtain financing. This means there are potentially cargoes with more than one owner, raising the possibility of defaults on loans and complex legal actions.
The authorities have yet to confirm they are investigating, but it seems more likely than not that any foul play will convince them to crack down further on the shadow banking system.
For physical commodities, the increasing concern over financing means that mainland markets may be disrupted in the short term, especially if there is distressed selling of stocks. This may serve to dampen imports for a few months as the inventory overhang is worked through, but thereafter the market should be more reflective of actual supply and demand.
Iron ore would appear to be the commodity currently most vulnerable in the short term, given the high inventories at mainland ports, the softer economic growth and the weak spot prices.